Enhancing Profitability

In their efforts to ensure profitability, top-performing electrical distributors focus on a “Balanced Scorecard” when managing their company's performance. The four stakeholders to address when applying these performance measurements are employees, customers, suppliers and shareholders. In measuring these stakeholders, you are trying to achieve a balance that's more than simple economic or profitability measures. Satisfaction measurements create this balance.

A link exists between profitability performance measures and satisfaction-performance measures. While this article will provide you with a road map to enhance your company's profitability, if you want to learn more about the subject, check out “The Service Profit Chain: How Leading Companies Link Profit and Growth to Loyalty, Satisfaction, and Value.” The book explores how managers at top-performing companies employ strategies that directly link and measure profit and satisfaction.

The five profitability measurements and four satisfaction measurements in the Balanced Scorecard on page 27 are performance measurements that can help electrical distributors attain high and sustained profitability.

EMPLOYEE PROFITABILITY AND SATISFACTION

Distribution is still a people-driven business. Employee expenses including payroll, payroll taxes, insurance and other fringe benefits often exceed 60 percent of total operating expenses. That's why employees are a major profit driver.

Sales-per-employee measures employee productivity. It's calculated by dividing net sales by the number of full-time employees. The sales-per-employee benchmark for high-profit electrical distributors is $400,000 in net sales. Therefore, if you have 15 full-time employees, you should be generating $6 million in annual sales to be considered a high-profit electrical distributor. Conversely, if you are doing $20 million in annual sales, to be a high-profit electrical distributor, you should have 50 employees.

You should conduct an employee-satisfaction survey annually with all employees to determine employee satisfaction. Utilizing a third-party to conduct your survey promotes honest and frank responses because it assures employees anonymity and confidentiality. Also, research shows survey response rates are higher when you use an outside research company. An outside company also provides a higher degree of objectivity to data collection and analysis. An example of one section of an employee-satisfaction survey is adjacent.

To calculate an Employee Satisfaction Index (ESI), simply add up the “very satisfied” (5) and “satisfied” (4) responses and divide by the total responses. For example, if 25 out of 30 employee respondents said they were “very satisfied” or “satisfied” with the company's total benefit package, your ESI for that category would equal 83 percent. An ESI rating of 80 percent or higher represents high employee satisfaction. Any ESI below 60 percent signifies low satisfaction among your employees. Once you have assessed where your employees are dissatisfied, you can determine the most appropriate strategies for raising employee satisfaction in those categories.

CUSTOMER PROFITABILITY AND SATISFACTION

Not all customers are equal. Some are profitable, and some are not. You can determine which of your customers are profit producers and which customers are negative profit producers by applying an Activity-Based Costing (ABC) system to your customers. This will help you calculate the cost to serve an individual customer with a Customer Profitability Index (CPI).

The following six steps will provide you with a true operating-profit contribution from each customer:

Some activity-based costing software provides the conceptual framework for linking customer transactional data to customer profitability. By measuring a customer's CPI, you can identify strategies to maximize each customer's contribution to your operating profit. A high-profit CPI for an electrical distributor is 4 percent.

The best tool to measure customer satisfaction is a customer-satisfaction mail survey. When you survey active customers or a statistically sound random sampling of your customer base, you receive scientific valid information on what customers as a whole think.

Customer satisfaction surveys should be conducted annually. The surveys should allow your customers to rate 20 or more service attributes. When mailing this questionnaire, enclose a new $1 bill as an inducement for customers to complete the survey. Research shows that survey incentives can increase response rates by as much as 57 percent. Your customer surveys should also include business-reply envelopes so these surveys can be easily returned. If a third-party conducts your customer-satisfaction study, you will also secure a higher return. A well-crafted, user-friendly survey sent to your entire customer base by a third-party should yield a 40 percent return. An example of one section of a customer-satisfaction survey is located above.

To calculate a Customer Satisfaction Index (CSI), simply add up the “excellent” (5) and “very good” (4) responses and divide by the total responses. For example, if 75 out of 100 customer respondents scored your company as “excellent” or “very good” with for order accuracy, your CSI for that category would equal 75 percent. A CSI rating of 80 percent or higher represents high customer satisfaction. Any CSI below 60 percent signifies low customer satisfaction. Once you have assessed where your customers are dissatisfied, you can determine the most appropriate strategies for raising customer satisfaction.

SUPPLIER PROFITABILITY AND SATISFACTION

Conducting an accurate supplier profitability analysis includes analyzing gross-margin return on inventory and a Supplier Profitability Index (SPI). Gross-margin return on inventory (GMROI) determines your return on inventory investment for each supplier by calculating how many stock gross-margin dollars are produced from each dollar tied up in inventory.

To calculate GMROI, simply divide gross-margin dollars on warehouse sales per supplier by the average warehouse inventory of that product line. This will help you make better decisions on the products to keep or delete.

For example, suppose you have a supplier on whose products you earned $80,000 in gross margin on warehouse sales last year. Your company held an average inventory of $60,000. If you divide $80,000 by $60,000 you arrive at a GMROI of 133 percent. This means that for every dollar you invested in inventory with that supplier, you earned $1.33 cents in gross margin on net sales through the warehouse. A good GMROI is between 130 percent and 160 percent. High-profit electrical distributors garner 160 percent in GMROI.

Using GMROI as the sole measure of vendor profitability has its limits. Gross margin can get eaten up fast by problems such as short shipment, wrong materials shipped, materials shipped damaged or defective products, missed promised delivery dates, partial shipments resulting in back order, pricing errors and billing errors.

A Supplier Profitability Index (SPI) is a much more valid representation of a supplier's profitability. High-profit electrical distributors attain 22 percent in SPI. The following six steps will provide you with a true profitability index from each supplier:

Categorize all steps you perform as a distributor when your supplier performs each of those supplier errors.

Record the amount of time spent on each step for each supplier error.

Establish a cost of the rework for each of the supplier errors.

Total all rework costs by supplier.

Subtract rework costs by supplier gross margin to arrive at the SPI.

A supplier-satisfaction survey should be conducted annually. Follow the 80-20 rule with suppliers. Assuming 80 percent of your purchases come from 20 percent of your suppliers, only survey your top 20 percent of your suppliers to secure an accurate Supplier Satisfaction Index (SSI): A brief example of one section of a supplier satisfaction survey is on page 28.

To calculate a Supplier Satisfaction Index (SSI), simply add up the “excellent” (5) and “very good” (4) responses and divide by the total responses. For example, if 15 out of 20 supplier respondents scored “excellent” or “very good” with your company's growth in total purchases, your SSI for that category would equal 75 percent. An SSI rating of 80 percent or higher represents high supplier satisfaction. Any SSI below 60 percent signifies low supplier satisfaction. Once you have assessed where your suppliers are dissatisfied, you can determine the most appropriate strategies for raising supplier satisfaction.

SHAREHOLDER PROFITABILITY AND SATISFACTION

Return On Net Worth (RONW) is a return on investment ratio based upon the owners' investment in the business. To compute RONW divide net income before taxes (NIBT) by net worth times 100. A RONW of 28 percent is a benchmark for high-profit electrical distributors. That means for every dollar of net worth, the electrical distributorship produced 28 cents of profits before taxes.

Shareholder/manager income is usually categorized in officer's salary. I have worked with high-profit electrical distributors whose officer's salary ranged from $400,000 to over 1 million dollars annually.

There is a balance of profitability and satisfaction for shareholder/managers. First, as a shareholder you seek a healthy return on investment. Then as a manager, you seek to be highly compensated for your efforts. Both a high RONW and high compensation counterbalance the risks of ownership.

BEST OF CLASS ELECTRICAL DISTRIBUTOR BENCHMARKS

Now it's time to put your company to the test and determine how you measure up with “best of class” electrical distributors. You can do this by using the “best of class” worksheet above. Achieving only a few of this worksheet's top-performance benchmark measurements will not get the job done. To reach high and sustainable profitability year after year, you need to hit all nine high-profit electrical benchmarks. Implementing these performance and profitability measurement will provide you with the right road map to guarantee profitable results.

Thomas J. O'Connor, president, Farmington Consulting Group, Farmington, Conn., is a strategy consultant for electrical distributors and a frequent contributor to Electrical Wholesaling magazine. You can reach him at (860) 676-7876 or by e-mail at tomoconnor@fcgltd.com.

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